Activity-based costing (ABC) allocates indirect costs to numerous cost pools. Each pool (eg, packing and shipping) includes costs that have common elements, usually a particular activity (eg, number of shipments) that will affect (ie, drive) the costs included in that pool.

The activity is called the cost driver, or allocation base. The cost driver allocates cost to each product (ie, cost object). In other words, ABC uses a rational allocation of cost based on the consumption of resources. Other cost systems (eg, job order costing) don't attempt to control indirect costs but rather arbitrarily allocate them to products based on mathematical formulas (Choices A and D).

ABC systems are often more reliable than other allocation systems due to the focus on identifying cause-and-effect relationships (Choice B). That is, cost drivers are identified and correlated to related activities to estimate indirect costs. However, one of the limitations of an ABC system is that data analysis can be quite expensive and gathering the data can be time-consuming.

Things to remember:
Activity-based costing (ABC) allocates indirect costs to cost pools, which are then assigned to various products. One of the limitations of ABC systems is that they require expensive data analysis to identify and measure cost drivers and their relationships to the indirect costs incurred.